Words Of Wisdom - P/BV (Price / Book Value) : Think before you believe in NEW TO TRADING & INVESTMENTS? - Can I buy a company if it quotes below its Book Value? Sounds to be a reasonable question, because Iím ...
08-11-2010 08:55 PM
P/BV (Price / Book Value) : Think before you believe
Can I buy a company if it quotes below its Book Value? Sounds to be a reasonable question, because Iím buying a stock at a value less than what its assets are worth for the equity holders(BV of equity). So any day, even if the business is planned be shut down, Iíll be able to sell it at a better price. Wow! Have I struck gold here. Think again. If the stock is trading below its book value, then either of these factors should be true
- The ROE of the company should be very low, say less than 10%. To be little more technical, the ROE will be less than the Required Rate of return (ie the risk of the share).
- For sure the business will have very erratic earnings pattern and there will not be good sales growth either.
- If it is a failing business and it has large goodwill on its balance sheet because of its past acquisitions that is of no use to me anymore. Hence that has to be deducted from the balance sheet.
- Is the company loaded with liabilities? Liabilities like debt beyond a certain limit will push stock prices below book value if it threatens earnings.
- Finally the Financial Service stocks like Banks might quote at a value less than their book value. The main assets of a bank are the loans that they have lent. These are the revenue generators for the bank. This revenue is going to be in a known limit unlike a manufacturing company where the revenue may be disproportionately higher as compared to their assets (Thanks to reasons like good will factor/asset utilization etc). Hence we believe the assets are priced according to the market value and shares will trade at those values itself.
If your stock doesnít fall into any of these categories but trading at a value less than half their book value then it might most probably be a undervalued stock.
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